sikiliza (< 20)

Airlines are Officially a Historic Relic

8

A lot has been said about the non-viability of high speed train systems in the United States, even citing China’s teething problems with it. Well, for how long are we going to keep propping up airlines that have failed to figure out a profitable business model?

American Airline’s bankruptcy is just one of a long list of failures that have now become unsustainable. Save for the auto industry (and the inane greed in the banking sector), there is no other sector that has seen the kind of blasé and idiotic leadership that the airline industry has portrayed. Since 1990, 14 airlines have filed for bankruptcies and some even went in twice – PanAm (in 1991 and 1998), TWA (1992, 2001) and US Airways (2002, 2004). In 2005, Delta, Comair and Northwest all went under.

There is something evidently wrong with an industry where:

The business has become so hopelessly complex - there can be close to twenty price points on a single flight for the same seat in the same class. Overlay that with over hundreds of different trip combinations between any two locations in any given week and you have a classic quant's nightmare

Ageing planes increase the risk of accidents, delays and even plain old collapse as was the case a few months ago when a Southwest plane mysteriously developed a hole in the roof

Passengers get charged for checked in luggage while carry-on luggage is free – if they want to free up the passenger cabin, shouldn’t they charge for carry-on?

Since KLM first flew in 1910, airlines have still not figured out the optimal number of bookings, flights and pricing for all the routes they operate – that is 100 years of failure in the making

They still carry defined benefit pension plans in an economy such as the one we have been facing for the last 10 or so years where predictability has totally gone out of the window. AMR has about $10B in unfunded liabilities for which it is looking to the American taxpayer to cover via the Pension Benefit Guaranty Corporation. In 2005, US Airways defaulted on $9.8B in pension obligations

Input costs including oil are only bound to sharply increase in the future while the entire industry tries to apply cost-cutting approaches to managing their challenges

Unions still hold an almost evil sway over the survival of the entire industry – I still do not understand their role in the 21st century

Frequent flier programs so large that they will never be fulfilled – in 2005, there were about 14Trillion unclaimed miles worth about $700B I would wager that that figure is now at 20Trillion worth about $1T. Really? Now, how did that ever happen?

Apart from Southwest (LUV) which has a 1% net Profit Margin and 2.54% ROE, airlines barely break even on the best of days – Only Spirit at 6.12% and Alaska at 5.8% margins seem to be bucking the trend for some mysterious reason

Off balance sheet obligations such as unfunded pension liabilities and equipment leases eclipse actual net assets on the books of the key industry players

Lastly, if employees are so disgruntled that they would rather fly off the handle as with the case of Steve Slater, a 38-year-old flight attendant, who cursed out an entire aircraft, grabbed a beer and then exited the plane by deploying the emergency slide, then things are really bad.

Interesting quote from David Einhorn (from Fooling Some of the People All of the Time, pg 10-11):

"I majored in government at Cornell University, but become more interested in economics after I interned during my junior year at the Office of Economic Analysis at the SEC in Washington. I wrote my thesis on the cyclical regulation of the U.S. airline industry. Policy makers balance two competing interests: Airlines want to make money, but customers want cheap, ubiquitous air transport. In the anti-competetive phase of the cycle, regulators allow airlines to generate generous profits by operating monopolies on routes, capturing cities as hubs, and eliminating competition by mergin. This leads to unhappy consumers and politicians, who then require procompetitive measures to provide cheaper service, which kills the profitability of the industry. After the airlines suffer through losses or even bankrupticies, policy makers realize that having airlines is a good thing. To induce airlines to buy planes and provide service, there has to be a profit opportunity, so the anti-competitive phase of the cycle returns. This vicious pattern perhaps explains Warren Buffett's quip that investors should have shot the Wright brothers' plane from the sky at Kitty Hawk. This thesis won me highest honors in the Government Deparment, and Greenlight, not surprisingly, has never owned a U.S. airline stock."

Given that people want to get places quickly, airlines won't be going away in our lifetimes. This does not make them a good place to invest, but they won't be going away.

Most of the US has such a low population density that high speed trains are a non-starter. California can't make them work economically and if they can't work there, they can't work in most states. Other than the Bos/Wash corridor, they are a bad idea.

High-speed rail could work, but our government has a very flawed transportation model. In fact, I would say our transportation system has become one of the most backward ones in the developed world. Instead of the government handing over everything to Amtrak, they should construct the high-speed rail routes and auction off the rights to operate to private companies. Private a subsidy if needed to make it sustainable.

Some might criticize a subsidy here, but it's impossible for high-speed rail to compete with the highway system, given the latter's heavy subsidies.

For the most part, we only need high-speed rail in the major metro areas. They should run a line from Boston down to Atlanta and a West Coast line from San Diego to Seattle. See how that works for a decade and then consider expanding.

As far as the airlines go, regulation, followed by deregulation is part of the reason for the massive number of bankruptcies. Since all the legacy carriers were started in the regulation era, their business models were all extremely flawed once deregulation came.

And you're right about the unions. That's the other problem. The legacy carriers have never been able to adapt because of the greed of the damned unions. I don't understand how unions are legal --- they are labor monopolies that fix prices and they've basically destroyed at least two American industries.

But it's important to note that not all airlines have failed. Southwest and JetBlue have both developed very good consumer-friendly models for the deregulation era. They've forced the legacy carriers to slowly change; but the problem for Southwest and JetBlue is that they're forced to pay above-market wages and deal with excess supply from the legacy carriers.